UK: Deloitte Monday Briefing (On Tuesday): Why Corporates Are Holding Cash

Last Updated: 2 April 2013
Article by Ian Stewart

Most Read Contributor in UK, August 2017

The Monday Briefing, written by Ian Stewart, Deloitte's Chief Economist in the UK, gives a personal view on topical financial and economic issues.

  • It is a paradox that while Western governments are seeking to curb borrowing corporates are running record cash balances.
  • The hope is that as governments reduce their budget deficits corporates will start to run down their cash surpluses to fund hiring and capital spending. In an act of synchronised rebalancing, government austerity will be more than offset by corporate expansion.
  • It is an attractive idea. Yet some of the factors that have led corporates to increase cash balances look as though they are here to stay.
  • In the UK official data show corporate cash balances stood at £671 billion in the third quarter, equivalent to 46% of GDP, up from £240 billion in 2002, and close to record levels.
  • This is not just a UK phenomenon. Though representing a lower share of national GDP, cash balances in the euro area and the US have hit record levels.
  • Part of the rise in corporate cash seems likely to be a response to the Global Financial Crisis.
  • Holding more cash can be seen as a prudent response to elevated uncertainty, an insurance policy against a riskier, slower growth world.
  • The Deloitte CFO Survey shows that improving cash flow has been a high priority for major UK corporates in recent years. The fact that the cash surpluses of Italian and Spanish corporates have risen far faster than those of German corporates fits with the idea that levels of corporate cash respond to country risk.
  • It is logical, too, for companies to hold more cash in a world where banks have become less willing and able to provide credit. In such a world companies are likely to have to finance more of their own spending. Moreover, there are sound reasons for companies to finance each other, through, for instance, supply chain finance which enables corporates to transfer surplus liquidity to their cash constrained suppliers.
  • The financial crisis has probably also reduced the risk adjusted cost of holding cash for many corporates. The opportunity cost of holding cash has fallen as returns on alternative investments have declined and meanwhile the perceived risks of deploying cash have risen.
  • Yet the run up in corporate cash balances long predates the financial crisis. Other, secular factors also seem to be at work.
  • Over the last 30 years improved inventory management techniques have reduced levels of corporate working capital. To maintain a given level of working capital companies have needed to raise cash balances. What seems to have happened is that firms have reduced their inventories and substituted cash for inventories on their balance sheet.
  • Another long term change has been the growth in research and development spending by corporates. Because R&D is often funded from cash corporates have needed to run higher cash balances.
  • Globalisation and the UK's role as a global hub for multinational corporations also seem to have contributed to corporate cash piles. Many multinationals chose to hold cash in the UK, even though much of it will eventually be deployed overseas. In 2012 42% of the capital spending undertaken by the top 1000 EU non financial companies was made outside Europe. Even if big corporates were to start to spend more freely much of it would probably take place outside Europe.
  • Finally, the rapid growth in the financial sector in the last 30 years has probably been responsible for a significant part of the growth in levels of cash.
  • Indeed, it seems likely that the official UK estimate of holdings of cash by non financial corporates – at £671 billion - have been exaggerated by including a significant proportion of cash held by hedge funds, private equity and other institutional investors. The Office of National Statistics is reviewing its methodology and will produce new estimates in June. These are likely to show that non financial cash holdings, while on a clear uptrend, are significantly lower than currently estimated.
  • What do the cyclical and structural drivers signal about the future direction of corporate cash balances?
  • The most effective way of reducing the precautionary motive for holding cash would be for macroeconomic risk, credit availability and economic growth to return to pre crisis levels. Few expect that to happen soon. And even if things were to improve, corporates would probably need some convincing to believe that it was back to business as usual.
  • The financial sector is clearly in a period of change and consolidation and this could weaken one of the drivers of corporate cash flow.
  • But globalisation, more efficient inventory management and higher levels of R&D intensity are here to stay. All tend to work in favour of historically high cash balances.
  • The amount of cash being held by non financial corporates in the UK is almost certainly overstated. Yet the underlying story, in the UK, US and euro area has been of a long term rise in corporate cash. The best way of decisively reversing that trend would be to convince the corporate sector that the good times are back. But so long as markets, the media and economists worry about growth, that is unlikely to happen. A return to pre-crisis levels of corporate cash look a long way off.

MARKETS & NEWS

UK's FTSE 100 ended the week flat.

Here are some recent news stories that caught our eye as reflecting key economic themes:

KEY THEMES

  • The Organisation for Economic Cooperation and Development (OECD) forecast the UK economy will grow 0.5% in the first quarter of 2013, avoiding a 'triple-dip' recession
  • Sentiment among Japanese manufacturers improved for the first time in three quarters according to data from the Bank of Japan's Tankan survey
  • US house prices are rising at their fastest pace since 2006, according to the Case-Shiller index, which rose by an annual rate of 8.1% in January
  • Sales of lower-rated US corporate 'junk bonds' rose to their highest weekly level in 2013, with $16bn of bonds going through capital markets, according to data from Dealogic and EPFR
  • Official figures showed France's nominal government deficit was 4.8% in 2012, missing its stated target of 4.5% for the year
  • The global pool of 'triple-A' rated government bonds, as rated by the top three global ratings agencies, has shrank by more than 60% since the onset of the global financial crisis according to Financial Times analysis
  • A £20m UK government scheme to lend to small businesses via the online peer-to-peer lender "Funding Circle" was officially launched
  • Tui Travel, owner of Thompson and First Choice, reported a 9% rise in UK summer holiday bookings compared with the same time last year, with people looking to escape the bad weather
  • The price of US natural gas rose to its highest level in a year and a half, with unseasonably cold conditions in big cities driving demand for fuel
  • Billionaire investor Warren Buffet became one of Goldman Sachs ten biggest shareholders, converting $5bn of share options which were purchased in September 2008
  • US private company Bristow Group won a 10-year contract, starting in 2015, to run the UK's helicopter search and rescue operations
  • Foxconn, which assembles many of the electronic products designed by Apple and Samsung, reported a record annual profit of $3.2bn, benefitting from last year's iPhone 5 release
  • Internet firm Yahoo! acquired Summly, an app that aggregates news stories, from its 17-year old British creator Nick D'Aloisio for "dozens of millions of Pounds"
  • US corn futures fell sharply on news of higher than expected stocks and government survey data suggesting farmers plan this year to plant the most corn since the Dust Bowl year of 1936
  • The number of people registering for membership of churches in the City of London has increased by 24% from 2007 according to figures released by the Diocese of London
  • The Financial Times reported that some eurozone politicians have light-heartedly discussed a potentially more appealing eurozone bailout, whereby citizens of northern European countries are given holiday vouchers that can only be used in Greece, Spain, Portugal or Cyprus – "Club Med option"

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